Term Paper

International Economics

Impact of Bureaucratic Quality on Trade Openness in

Pakistan

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Introduction
Bureaucracy has a very crucial role in the governance itself because one cannot disassociate the
state from the governance process. An efficient bureaucracy is imperative to advance good
governance. The primary function of bureaucracy is the execution and enforcement of the laws
made by the legislature and policies decided by the political executive. In Pakistan, path
dependence policies have made bureaucracy inefficient to carry out their duty. This gradual
demise of in the bureaucratic efficiency has trickle down affect to other macroeconomic
indicators.
The need to understand bureaucratic quality is essential as it shows the state capacity to coup
with multifaceted problems. A country with strong state capabilities might be able to draw from
the full menu and pick and successfully implement those policies that best suit the nature of the
shocks the country faces as well as its economic and social fabric. The concept of “state capacity”
is very salient in studies of economic development, and its presence or absence has been
associated with development successes and failures. It has many dimensions, such as coercive or
military capacity, fiscal or extractive capacity, administrative or implementation capacity, and
legal capacity. The type of economic and social policy implementation capabilities, referred here,
come closer to the notion of administrative or implementation capacity (Franco, 2014). Thus,
understanding bureaucratic efficiency will simply translate into the nature of state capacity.
Evans & Rauch (2010) presented the historical analysis by emphasizing the role of bureaucratic
efficiency for economic growth. Meritocratic recruitment of bureaucracy significantly enhance
prospects for growth. International Country Risk Guide termed bureaucratic quality as the “shock
absorber that tends to minimize revisions of policy when governments change”1.
Although, a whole spectrum of scope of bureaucratic quality can be studies, however, this study
only emphasize the role that bureaucratic quality plays in any country’s trade openness, exports
and imports. Thus the relevant question is the one having to do with the consequences of trade
policies formulated by the bureaucracy in Pakistan. The inefficiency of bureaucracy takes a shape
when it comes in the form of corruption. It will be revealing to know whether the incidence of
bureaucratic corruption is increasing in trade policies offered to the domestic industry, both in

1
International Country Risk Guide (http://www.prsgroup.com/wp-content/uploads/2012/11/icrgmethodology.pdf)

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terms of protection from foreign competition as well as through the subsidization of production.
Whether corruption is decreasing in the remuneration of bureaucrats and in the checks and
balances on the bureaucracy offered by a democratic polity, an educated public and a vibrant
media.
Moreover, this critical relation of trade openness and bureaucratic quality offers several policy
implications. First, when thinking optimal tariffs, subsidies, and infant industry protection
arguments, policymakers must recognize that there may be a flip side to the arguments for
transferring rents from foreigners to domestic producers that encourages corruption on part of
the bureaucracy (Dutt, 2006).
One antidote to mitigate bureaucratic inefficiency is though trade liberalization. It has the
potential of mitigating corruption and improving the governance structure. As it has been
observed in selected Pacific Island Countries (PICs), Gani & Prasad (2006) argued that if these
countries opt for liberalized policies, the problem of weak institutional quality will dissipate over
the time. Hence, the research directs us towards bi-directional causality between trade openness
and bureaucratic quality2.
Having better bureaucratic quality converges the trade volume for trading partners as it becomes
mutually beneficial for both countries. Estimations show that institutional similarity eases
bilateral trade. The fact that two countries have the same institutional framework increases
export volumes by 60% (Lavallée, 2005).

Moreover, the presence of internationally mobile capital and skilled workers in an open economy
should force government to perform. Surprisingly, the empirical supports for the impact of
bureaucratic efficiency on openness are few despite compelling antidotes. Particularly in case of
Pakistan, due to lack of data availability, this dimension has not yet been explored by researchers.

2
This study is using “bureaucratic quality” as proxy for institutional quality. Hence both terms are being used for each other.

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Rationale of the Study

Given the intriguing nature of the relation, this study will explore relation between bureaucratic
quality and trade openness, imports and exports with special reference to Pakistan. Whether
there is any significant relation between quality of government official and their controlling the
policy regime.

Literature Review
Evans & Rauch (2010) explored the effect of bureaucratic quality in historical context. They
associated the role of bureaucratic quality for growth in Weberian theory. The role of
bureaucratic authority in facilitating economic growth has been a sociological concern since Max3
Weber’s classic contributions of almost 100 years ago. Using a recently collected, original data
set, they examined the characteristics of core state economic agencies and the growth records
of a sample of 35 developing countries for the period 1970-1990. The authors concluded that
Weberianness” should be included as a factor in general models of economic growth. They also
suggest the need for more attention by policy makers to building better bureaucracies and more
research by social scientists on variations in the way state bureaucracies are organized.
Dutt (2006) examined whether protectionist policies, on the part of the government, leads to
increased bureaucratic corruption. Using multiple measures of corruption and trade policies,
author found strong evidence that corruption is significantly higher in countries with
protectionist trade policies. A panel-data based GMM methodology was used to estimate a
dynamic model of corruption. This estimator controls for country-specific effects, potential
endogeneity of trade policy, and existence of measurement errors afflicting the corruption data.
The results were robust to endogeneity problem. The paper argued the case for trade
liberalization and argues that trade reforms may lead to improvements in governance.
Gani & Prasad (2006) explored the impact of institutional quality on trade in selected Pacific
Island Countries (PICs). Four indicators of institutional quality were chosen: government
effectiveness, rule of law, regulatory quality and control of corruption; for six PICs (Fiji, Kiribati,

3
Max Weber (1864-1920), a German Sociologist, was the first thinker to emphasize on bureaucracy. He argued that
bureaucracy constitutes the most efficient and rational way in which one can organize human activity.

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Samoa, Solomon Islands, Tonga and Vanuatu). This paper examined that export, import and total
trade determinants using reduced form equations for six Pacific Island countries with an
institutional focus. Controlling for common determinants of trade, four indicators of institutional
quality: government effectiveness; rule of law; regulatory quality; and control of corruption are
chosen. The fixed effects model, controlling for AR(1) errors, indicated that improvements in
institutional quality variables matter for improved levels of trade.
Lavallée (2005) used a gravity model to assess the impact on trade of the proximity and the
quality of institutions. A new index of institutional similarity was proposed. It was computed on
the basis of data on national legal traditions. The model included 145 countries and is estimated
with panel data over the period 1984-2002. The estimation results clearly showed that
institutional proximity increases bilateral trade. However, this paper also revealed the impact of
bad governance, and especially of corruption on international trade.
Franco (2014) tested and proved a positive relationship between a country’s level of trade
openness and the size of its government. This paper argued that there are a number of
macroeconomic, fiscal, industrial, and social policies that can mitigate trade-induced risks, many
of which do not have the necessary implication of increasing public spending. For that reason,
the relationship between openness and the size of government might be mediated by the quality
of its public sector. Using the quality of the bureaucracy as a proxy for government capabilities,
the study showed that the conditional effect of openness on the size of government is only
positive and significant for low levels of government quality. As bureaucratic quality increases,
the effect of openness on government´s size decreases and it even dissipates. Therefore, the
results indicated that the effect of openness on government consumption is mediated by the
quality of government institutions.
Alesina & Wacziarg (1998) argued that country size is negatively related to government size, and
that it is also negatively related to trade openness. Large countries can afford to have smaller
governments (and therefore lower taxes) and they already benefit from a sizable market which
reduces their need to be open to trade. The study concluded that smaller countries have a larger
share of public consumption in GDP, and are also more open to trade. These empirical
observations are consistent with recent theoretical models explaining country formation and

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break up, and may account for the observed positive empirical relationship between trade
openness and government size.
Chan (2002) examined whether or not there is empirical evidence that trade can discipline
domestic government bureaucracy. There is strong evidence that, despite their interventionist
and authoritarian governments, many open economies in Southeast Asia, such as Singapore,
South Korea, and Taiwan, are well governed, with an efficient and relatively uncorrupted
bureaucracy. This intimate relationship between effective institutions and a liberal trade regime
in East Asian economies suggest that trade might have acted as a market discipline device for the
Asian governments to perform efficiently. This article has confirmed empirically that trade can
discipline the performance of government bureaucracy.
Freund & Rocha (2010) examined the effects of transit, documentation, and ports and customs
delays on Africa’s exports. The study found that transit delays have the most economically and
statically significant effect on exports. A one day reduction in inland travel times leads to a 7%
increase in exports. An augmented gravity equation was estimated by regressing aggregate
bilateral exports on different time delay components (inland transit, documentation, ports and
customs) and other standard gravity variables. To control for the possibility that more trade leads
to improved trade facilitation, the study investigated the effects that documentation, inland
transport, customs and ports times respectively have on the exports of new products. Exports in
these products are unlikely to have an impact on the historical development of infrastructure.
Islam & Reshef (2007) estimated the impact of institutions on bilateral trade flows in a gravity
equation. It was tested that how much differences in institutional form or design matter for
trade. The empirical estimations indicate that the impact of bad institutions (inefficient
bureaucracy), corruption and poor property rights protection, is a much larger deterrent to trade
than the impact of differences in form as proxied by differences in legal systems. This is
particularly true in poor countries.
In a nutshell, a sizeable quantity of literature suggests that institutional quality significantly affect
the trade openness, imports and exports. Within the indicators of institutional quality,
bureaucratic quality seems to be playing dominant role as it directly related to the government
size and control. Although corruption and rule of law are also employed in many researches,

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bureaucratic quality has its vital place in this discussion. Thus, this research will employ model
involving the role of institution (measured in terms of bureaucratic quality) to capture its effect
on trade openness in Pakistan.
Data & Methodology
Since this study focus only on Pakistan, it will employ time series econometric techniques to find
the results.

This study will regress the following model:

Trade balance = f(PCGDP, CPI, BQ)

Where

 Trade balance is the sum of imports and exports. This variable is used as proxy for trade
openness. The data is taken from World Economic outlook for the year 1984-2013.
 PCGDP is per capita GDP measured in US million dollars. The data is taken from World
Economic outlook for the year 1984-2013.
 CPI is average consumer price index. The data is taken from World Economic outlook for
the year 1984-2013.
 BQ is bureaucratic quality, this variable is generated with the help of data taken from
International Country Risk Guide (ICRG) and World Bank Governance Indicators.

The following will be the functional form of the regression equation:

tradeBalance = β0 + β1PCGDP + β2CPI + β3BQ + u
The relationship between trade balance and bureaucratic quality can be studied through
different ways in time series analysis. As our objective is to find causality and relationship
between trade balance and bureaucratic quality, for this purpose, most of the literature refers
us to the techniques such as ADF test, Granger Causality test, Cointegration technique and Error
Correction Model (ECM).

Augmented Dickey-Fuller (ADF) Test:

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Regression analysis based on the time series data implicitly assumes that the underlying time
series data are stationary. But in practice, generally macroeconomic time series data are non-
stationary. So stationarity can be checked by finding out if the time series data contains a unit
root. Augmented Dickey-Fuller (ADF) test can be used for this purpose.
Suppose we want to make one of the variable per capita GDP (PCGDP) a stationary variable. Then
we will regress the following equation:

D(GDP) =  +  D[GDP(-1)] + t …………………… 3.1

And we will hypothesize as

H0: =1  Non stationary (there is unit root)

H1: <1  Stationary

If ADF stat > critical value

then reject H0 , Otherwise do not reject H0

In this way we will make all of our variables stationary.

Granger Causality Test:

Granger Causality Test at lag length one is applied in the following way:
If we want to know the causation between trade balance and bureaucratic quality i.e., whether
bureaucratic quality(BQ) cause trade balance (TB) or trade balance cause bureaucratic quality
(uni-directional causation), or both cause each other (bi-directional causation).
Then the following equations will be estimated:
TBt = 1 + 2 TB (-1) + 3 TB(-2) + 4BQ(-1) + 5 BQ (-2) + 1t

BQt = 1 + 2 BQ(-1) + 3 BQ (-2) +4 TB (-1) + 5 TB(-2) + 2t

And we hypothesize as follows for the above equations:

H0: 4 = 5 = 0  bureaucratic quality do not cause trade balance

H1: 4  5  0  bureaucratic quality do cause trade balance

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And

H0: 4 = 5 = 0  Trade balance does not cause bureaucratic quality

H1: 4  5  0  Trade balance do cause bureaucratic quality

In this way, we find the causal relationship between defense expenditures and economic
growth.

Cointegration Technique:

Cointegration of two or more time series variable suggests that there is a long-run, or equilibrium,
relationship between them.

Some or all of the variables involved could exhibit non-stationary trends. Also, high R2 value may
arise as a result of correlated trends and not through economic relationship. The standard
method for overcoming this problem is to see whether the relationship discovered in levels
persist after first differencing. The problem with such an approach is that is involves the loss of
frequency (long-run) information. The assertion that there is a long-run relationship between
bureaucratic quality and trade openness in Pakistan necessitates the use of an econometric
methodology that overcomes the problem of spurious regression. In this regard, cointegration
allows the identification of non-spurious relationship without forcing the loss of long-run
information.

Formally, if bureaucratic quality (BQ) and trade openness (TB) are both non-stationary in levels
but stationary in first difference, they are said to be integrated of order one, denoted by 1(1).

As BQ and DE are both 1(1), their linear combination of the form

Zt = TBt –  BQt

are generally also 1(1).

However, if there is an  such that Zt is integrated of order zero i.e., 1(0), the linear combination
of TBt and BQt are said to be cointegrated.

In sum, the following steps are involved in cointegration technique:

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 i. The variables BQ and TB must be stationary at same level i.e., 1(1)
ii. Apply OLS to the following equation:
TBt = 1 + 1 BQt + 1t

Then generate the series for residual i.e., a new variable like (Resid01)

iii. There linear combination must be 1(0) i.e., apply unit root test on residual series
If Resid01  1(0)

Then there is cointegration, means that there is long-run relationship between economic
growth and defense expenditures.

Results & Discussion

The results of the above model reveal the positive and significant relation between bureaucratic
quality and trade openness. We estimated two regression models one as simple OLS regression
and second with difference equation. Following table shows the results of both regression
equations. As it can be seen, bureaucratic quality is significant and have positive relation with
trade openness. A one unit increase in bureaucratic quality will increase the trade openness by
eighteen units. However, per capita GDP and CPI does not seem to have any relation with trade
openness as both of the variable are insignificant in both models. While the simple regression
model has better Durban-Watson statistics, the difference model has better R2 (for detail
information, see attached appendix).

Dependent var= Trade Balance Simple Equation Difference Equation

Independent Variable Coefficient P-Value Coefficient P-Value
Bureaucratic Quality 18.16790 0.0443* 39.00069 0.0202*
CPI -0.049944 0.8021 0.491953 0.4967
Per Capita GDP 0.021473 0.4884 0.039942 0.5286
2
R 0.189348 0.245986
Durban Watson Stat 1.702961 2.491747
*shows significant values

Both, trade openness and bureaucratic quality, have long-run relation as the cointegration test
has shown existence of cointegration between these two variable (see Appendix). However,
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Granger Causality test gave insignificance results which means there is no causality between
these two variable. This is strange and contradicting result as contradiction is showing long run
relation but there is no causality. This must be data related problem because R2 is also
significantly low for this time series analysis. Nonetheless, the positive and significant relation
which is established between trade openness and bureaucratic quality is encouraging result,
particularly for this simple study.

Conclusion

In this study, the relation between bureaucratic quality and trade openness has been tested for
Pakistan. Taking a data from 1984-2013, the simple time series analyses were conducted on the
above mentioned variables. The results of the model are positive and significant stating the long
run relation between bureaucratic quality and trade openness in Pakistan. Thus, for Pakistan to
improve trade openness, imports and exports, the quality of bureaucracy has to be improved up
to international standards. The mediocrity of the bureaucrats is a hindrance in our liberalized
trade.

Limitations of Study

Since this research is simple in its nature, a much more rigorous approach and econometric
modelling is required to announce policy implications. More Data and more variables are
required to comprehensively capture the effect of bureaucratic quality on trade openness.

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References

 Evans, P., & Rauch, J. E. (1999). Bureaucracy and growth: A cross-national analysis of the
effects of" Weberian " state structures on economic growth .American sociological
review, 748-765.
 Dutt , P. (2009). Trade protection and bureaucratic corruption: an empirical
investigation. Canadian Journal of Economics/Revu canadienne d'économique, 42(1),
155-183.
 Gani, A., & Prasad, B. C. (2006). Institutional Quality and Trade in Pacific Island
Countries. Asia-Pacific Research and Training Network on Trade Working Paper
Series, 20.
 Lavallée, E. (2005). Institutional similarity, Institutions ‘quality and trade.EURIsCO, Paris:
Universite Paris Dauphine.
 Franco, M., Scartascini, C., & Tommasi, M. OPENNESS, STATE CAPACITY, AND THE SIZE
OF GOVERNMENT.
 Chan, K. S. (2002). Trade and Bureaucratic Efficiency*. Economic Development and
Cultural Change, 50(3), 735-754.
 Freund, C. L., & Rocha, N. (2010). What constrains Africa's exports?. World Bank Policy
Research Working Paper Series
 International Country Risk Guide (ICRG), (http://www.prsgroup.com/wp-
content/uploads/2012/11/icrgmethodology.pdf)
 World Economic Outlook, 20015, International Monetary Fund(IMF)
 World Governance Indicators, the World Bank
 Roumeen Islam & Ariell Reshef (2007), “Trade & Harmonization: If Your Institutions Are
Good, Does It If They Are Different?”, World Bank Policy Research Working Paper 3907
 Alesina & Wacziarg (1998), “Openness, Country Size and Government”, Journal of Public
Economics, Vol.69 pp. 305–321

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Appendix

Original without difference:

Dependent Variable: TB
Method: Least Squares
Included observations: 30
Variable Coefficient Std. Error t-Statistic Prob.
C -33.66940 20.92793 -1.608826 0.1197
PCGDP 0.021473 0.030550 0.702888 0.4884
CPI -0.049944 0.197203 -0.253262 0.8021
BQ 18.16790 8.596330 2.113448 0.0443
R-squared 0.189348 Mean dependent var 10.99633
Adjusted R-squared 0.095811 S.D. dependent var 12.21934
S.E. of regression 11.61923 Akaike info criterion 7.866766
Sum squared resid 3510.170 Schwarz criterion 8.053592
Log likelihood -114.0015 F-statistic 2.024317
Durbin-Watson stat 1.702961 Prob(F-statistic) 0.135134

With Difference:
Dependent Variable: DTB
Method: Least Squares
Included observations: 29 after adjusting endpoints
Variable Coefficient Std. Error t-Statistic Prob.
C -2.807962 4.425007 -0.634567 0.5315
DCPI 0.491953 0.713301 0.689684 0.4967
DBQ 39.00069 15.72334 2.480432 0.0202
DPCGDP 0.039942 0.062503 0.639048 0.5286
R-squared 0.245986 Mean dependent var 0.692103
Adjusted R-squared 0.155504 S.D. dependent var 16.10183
S.E. of regression 14.79701 Akaike info criterion 8.354170
Sum squared resid 5473.789 Schwarz criterion 8.542762
Log likelihood -117.1355 F-statistic 2.718628
Durbin-Watson stat 2.491747 Prob(F-statistic) 0.065960

Cointegration
Dependent Variable: DTB
Method: Least Squares
Included observations: 29 after adjusting endpoints
Variable Coefficient Std. Error t-Statistic Prob.
C 1.015865 2.724789 0.372823 0.7122
DBQ 33.53242 12.87144 2.605181 0.0148
R-squared 0.200875 Mean dependent var 0.692103

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Adjusted R-squared 0.171278 S.D. dependent var 16.10183
S.E. of regression 14.65817 Akaike info criterion 8.274345
Sum squared resid 5801.272 Schwarz criterion 8.368641
Log likelihood -117.9780 F-statistic 6.786966
Durbin-Watson stat 2.522493 Prob(F-statistic) 0.014755

ADF TEST ON RESIDS for cointegration

ADF Test Statistic -5.615237 1% Critical Value* -3.6959
5% Critical Value -2.9750
10% Critical Value -2.6265
*MacKinnon critical values for rejection of hypothesis of a unit root.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(R)
Method: Least Squares
Included observations: 27 after adjusting endpoints
Variable Coefficient Std. Error t-Statistic Prob.
R(-1) -1.689560 0.300888 -5.615237 0.0000
D(R(-1)) 0.339860 0.186761 1.819762 0.0813
C -0.161057 2.619834 -0.061476 0.9515
R-squared 0.679307 Mean dependent var 0.722333
Adjusted R-squared 0.652583 S.D. dependent var 23.06981
S.E. of regression 13.59783 Akaike info criterion 8.162136
Sum squared resid 4437.622 Schwarz criterion 8.306118
Log likelihood -107.1888 F-statistic 25.41900
Durbin-Watson stat 2.161750 Prob(F-statistic) 0.000001

Causality

Pairwise Granger Causality Tests

Sample: 1984 2013

Lags: 2
Null Hypothesis: Obs F-Statistic Probability
DBQ does not Granger Cause DTB 27 0.06964 0.93294
DTB does not Granger Cause DBQ 1.40212 0.26722

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